Thursday, 7 April 2016

No Japanese Surrender.

It might not have escaped your notice that the Japanese Yen is screaming higher. Which may be odd as it's usually a counter-carry currency that goes up in times of stress as the money comes home. Is there carry stress out there? EM has been performing, credit has rallied so on the face of it there isn’t a reason to unwind your carry trades other than they are sinking underwater due to the move in the Yen itself. This is a circular reinforcement argument which for money management rules is just as valid as a decrease in yield differentials. Capital losses versus interest losses. Carry trades are inevitable sawtooth in nature as they creep upwards looking for interest differential and collapse on self reinforcing capital preservation trade unwinds. Hence the inevitable skew in the risk reversal option pricing. On the carry trade argument the move in Yen looks like a carry capitulation.

The major driver to everything Yen is the great BoJ Abenomics experiment. Here Abenomics are the CERN of monetary policy experimentation. It is the biggest and boldest experiment into discovering how the monetary universe really works. Observations on the path of the yen would currently suggest that there is a need for monetary dark matter to explain the difference between theory and observed reality.

On a pure printing of money basis, a Yen's value is a function of the number of Yen in circulation versus the total net worth of all assets denominated in Yen. Econ 1.0.1 says the more Yen in circulation against fixed valued assets, the lower the yen is valued against those assets. Abenomics is focused around Yen creation to cause it to devalue. So why is the Yen screaming higher especially against the USD where the opposite is more likely to be occurring? It really depends on what you do with your printed money. Parking it back into your own hoarding systems just doesn’t work. It needs to get out there into the Economy. One way would be to lend to US banks or invest directly in offshore assets, other overseas bonds, and park them in a form of Sovereign Wealth Fund. The Japanese Post Holdings has always been a quasi-state institution that even after partly IPO'd, it must have enough State interest to still be able to cover foreign asset ownership.

Of course if they wanted to bypass all the pretence they should just print Yen, sell it for Euros and buy German car companies. Nothing like reversing your currency, countering deflation and acquiring your competition all effectively for free. It may sound nuts but if someone is seriously willing to take your newly minted money, which is just a movement of electrons in the world of electronic banking, and exchange them for huge tangible assets then I would bite their hand off.

Whilst the Yen has been strengthening and Nikkei correspondingly falling, questions are being asked as to whether monetary policy has reached the end of the road. Though I may agree that the policy embarked upon in Japan will not work when to comes to generating growth, it will, if enough is thrown at it, cause inflation, even if inflation doesn’t lead to growth. We just need the dam in the transfer system to breach as currently it’s as though the toilet has been flushed but the U-bend is blocked.

Will Abe give up on his policy? Will the Japanese, to whom ‘face’ historically and culturally has been something that has always had to be saved, be willing to accept that they have been wrong? Instead of surrender I would expect them to go bezerk (in the true meaning of the word) and go madly into attack. Considering this and the path of the Yen so far together with their world leading experimentation into monetary policy I would strongly suspect that they will go all in and aggressively buy equities. Abe's Alamo.

For this reason I am buying Nikkei, JPY hedged, as it will benefit directly and via a retrace in the Yen caused by a shock and awe action. Considering the the potential move down before up again on timing I am looking at options too.

Now to touch upon contiguous market dynamics. The Yen's fall has now picked up market attention and while correlation with 'rest of the world' stocks has been low recently, when we hit acceleration mode it adds to the general mood of concern. Everything ‘risk' today looked awful. Copper fell to bits having breached the support we've been using for a while (yes I got stopped out of longs there).

Oil fell, the single European bellwether of DB stock fell and we ended up with SPX plumbing the lows. But, interestingly holding that 2032 area that has been support/resistance congestion for a while. Why interesting? Because the markets felt as though they were going to accelerate to the downside and didn’t.

The UK’s FTSE has been outperforming other markets on a % index basis despite the commodity sell off, but much of this can be explained by GBP's fall (which is being blamed on fears over the EU referendum) and the GBP valuation of UK listed non-UK dependent businesses. The GBP fall is meanwhile making the UK even more competitive and relieving any disinflationary pressures. So here’s the irony -

What Abenomics has failed to do in Japan over years, the UK has managed to achieve in only weeks by suggesting it may leave Europe.

3 comments:

Abe may be about to go "Bezerk" but I'm starting to get the screaming Ab-dabs.

I had considered referendums as monetary policy myself. Find yourself a winnable issue (Scottish independence, Brexit etc.), let the issue fester for months steadily heightening fears in the currency markets. Then, at the last minute, get your act together, bring out all the big guns and properly scare the f*ck out of voters (and markets) with the sheer fear of the unknown.

Voters may naively think that Cameron has wasted his entire time in office campaigning for things he never needed to do in the fist place, but the plebs (as in the original meaning of the word) clearly don't grasp the subtlety of monetary policy today.

The only question to my mind is, what will they think of next....Cornwall?

re UK - except that it also managed to run humongous current account deficits, which in case of Brexit will almost certainly transform into a sterling crisis. And the very large question then would be, will BoE step in? It can't really buy enough sterling to make any difference, so rates up is the only thing it can do. How large (if any) would have the drop in sterling be, for it to step in?

The FX moves are meant to help rebalancing CA, but that assumes you can substitute the imports. Which I'd say in the UK is unlikely (for example, UK's car production and models are unlikely to satisfy the market). At the same time, the services exports, the largest export contributor, would suffer with Brexit (there's not free trade in services, not even within EU really). So the UK economy would have to rebalance massively. Or UK would slip into even more of a second rate power, at least for some time (until some rebalancing came).

But if you don't get good results (i.e. more exports, less imports) from the currency down, that means more unemployment, more inflation, raising the rates significantly (and there's no point of raising rates 25 bips if sterling falls 10%), which in effect would then translate into raising mortgage rates, would mean housing crash, and a potential bank crash.

I'd say in case of brexit buy footsie ex banks. It's going to crash on T+0, but given that its income is mostly non-GBP, it should bounce pretty strongly pronto.